#Brexit + #fintech: What happens now?

Shefali Roy is the former European Compliance Officer and Money Laundering Reporting Officer for Stripe. Prior to Stripe, Shefali headed up compliance, business conduct and risk across Europe, the Middle East, India and Africa for Apple, was the Chief Compliance & Ethics Officer for Christie's worldwide and worked in private wealth compliance for Goldman Sachs across Europe. She has undergraduate qualifications in law, economics and finance, and postgraduate qualifications in journalism and economic history, from RMIT, Oxford and LSE respectively. She is presently undertaking an EMBA from Oxford's Said Business School.

The British public recently voted to leave the European Union. Only history will tell whether it was a good decision or not. The immediate issue is… what happens now? Those in financial services and technology firms will have to grapple with the unraveling of treaties that will have a direct impact on their business. But first… what happens next?

The U.K. has to invoke Article 50. In essence, Article 50 — a version of which has only ever been invoked once, by Greenland in 1985 when they were part of the EU’s predecessor, the European Economic Area (EEA) — determines the process of a member country leaving the EU. Prime Minister David Cameron said in his resignation speech that he expects the new PM to be appointed next October at the Tory Party Conference, and that that PM will issue the Article 50 notice to the EU.

Two years seem like a long time, but as those who work in financial services know, EU directives take years to be drafted, consulted, transposed and implemented nationally in EU member states. It takes substantially longer than two years. To expect an entire nation — the second largest economy in the EU — to withdraw completely within two years is ludicrous. However, it isn’t unrealistic for the EU to ask the British to start thinking about invoking Article 50 immediately so there is a swift, smooth transition out of the EU so as to manage and mitigate market volatility and prolonged uncertainty.

Once notice is given, negotiations begins. The U.K. will have to do its utmost to try to retain the existing state it has: access to the single market, free movement of labor, equitable financial regulations, existing import-export trade-offs and a say in the formulation of broader policy. There are potentially three models the U.K. could end up with:

The Norway model. The U.K. retains trade and single market privileges, as if it were a member of the Union. Like Norway, they are participants in EFTA — the European Free Trade Agreement. The U.K. would have to implement all EU rules in exchange for access to the EU market, but would have no say on the rules themselves.

The Switzerland model. As with Switzerland, the U.K. isn’t a de facto member of the Union. They must implement and abide by their own financial services regulations and rules like Switzerland and formulate new bilateral trade deals with the EU.

The non-EU country model. The U.K. is treated as if it were any other non-European country in the world and must negotiate its entry into Europe from a first principles basis. Think of this situation as if the U.K. were Singapore or Peru.

It’s arguable at this stage which model is best suited for the U.K. The outcome of where the U.K. ends up will depend on the strength of the negotiators. One wonders whether having Boris Johnson/Michael Gove or Nigel Farage or Jeremy Corbyn at the helm will be to the U.K.’s advantage; consensus implies no. U.K. commentators suggest that the Norway model is the way to go; however, the recent rhetoric of the EU negotiators suggests that that option won’t be on the table.

Only history will tell whether it was a good decision or not.

Given this, fintech firms may have to broadly think of the following issues, and formulate plans to combat them. (For the purposes of this essay, fintech here refers to those payment firms that are either regulated as eMoney Institutions (EMIs) or Payment Institutions (PIs) by the U.K.’s Financial Conduct Authority. Their core business could include payment processing, peer-to-peer payments, e-money, online wallets, crowdfunding, online lending, mass remittances and FX payments, to name a few.) The list is not exhaustive:

People: London is privileged to have talented people from all over the EU working here. Because of the single market and free movement of labor, anyone in Europe can work here with minimal labor and employment law bureaucracy. With the growth of the fintech sector, what makes or breaks firms is talent. London will be at a competitive disadvantage if the non-EU country model is what the British end up with. To reduce that disadvantage, British finance firms have already started moving some of their operations out of the U.K. — and their people too.

Skills: The fintech industry is vying and competing for engineers, software developers, cybersecurity analysts and advanced technological thinkers. By exiting the EU, the industry here is looped out of a nearly 500 million-person labor pool that would enable them to remain competitive and, more importantly, current.

Investment: Investment and venture capitalists’ access to fintech startups here will be severely impaired. In addition to the opportunities to pitch, and access to funds that have been affected by negative tax incentives, it is arguable that fintech firms would benefit more from U.S. VCs or China VCs than those in their own backyard.

Access to the single market and the digital market: This would be part of the negotiation, but unless the Norway or Switzerland model is adopted, it’s likely that the U.K. will lose access to the EU and any innovative and forward-thinking digital market initiatives, including e-KYC, the security of internet payments, e-residency programs and e-corporations.

Privacy/data protection/security: For U.S. companies operating in the EU, the ending of the Trans-Atlantic Safe Harbor Treaty was a blow to their operations. The introduction of the new EU-U.S. Privacy Shield was a step in the right direction, but many Europeans argued it didn’t go far enough to protect the data, security and privacy of EU citizens. Now, not only will the U.K. need to negotiate new privacy/data protection and security terms with the EU, it will also have to do so with the U.S. U.K. firms wanting to operate in the EU will need to build in provisions for EU-specific requirements, and now, also look to the U.S. to engage in U.S.-specific obligations.

Regulation: Presently, there is a plethora of EU directives being negotiated at the EU level that will in due course need to be agreed upon, transposed and localized by national regulators in local jurisdictions. The directives, include for example, PSD2, 2EMD, MLD4, Security of Internet Payments and Interchange Charge Regulation. These will potentially grind to a halt until such time that the regulators of the affected member states know what the next steps are. Key amongst this for U.K. fintechs is they potentially will lose their ability to “passport” their services into the EU. This is a potentially disastrous blow for U.K. fintechs that want to scale operations into the EU. Which begs the question… which regulator next?

U.K. fintechs have had the privilege of being regulated in the U.K. by the Financial Conduct Authority — a progressive, innovative, business-friendly regulator. They’re tough, but they are pragmatic, efficient and have enough clout amongst other national regulators to play a key role in shaping and implementing EU-wide regulations. These advantages of the FCA disappear after #Brexit. The most important question for U.K. fintechs now is: Where should they go to get regulated to allow them to continue to get the benefits of the single market?

Some fintech startups have considered seeking regulatory licenses in Spain, Italy, Ireland or the Netherlands. The rationale is either that they already have operations in or familiarity with these countries, and it would be an easy marginal cost argument to continue to double down on these bets. However, while there are other competent regulators in Europe, Germany is probably the most commonsensical choice, for many reasons:

They last year published numerous articles on fintech — Bitcoin, payments, internet payment methods, crowdfunding and the state of fintechs.

Having an efficient and controlled regulator is better for startups in the long run because it allows the regulated firm to have a competitive advantage against their competitors — customers prefer firms they can trust. Certain regulators and countries inspire more trust than others, so from a customer perspective, the BaFin would be a solid choice.

Within the national regulators that contribute EU regulations through the European Banking Authority, BaFin is a powerful ally, which is a help to U.K. fintechs as the BaFin would be the leader in transposing EU directives into local law, which will allow firms to adapt to new regulations swiftly and cost-effectively.

Aside from that, Germany has a robust, buoyant and technologically advanced fintech community that would welcome and adapt to U.K. firms and their services.

While it is certain that there are still many unknowns yet to be ironed out after this disastrous turn of events for Britain, the unequivocal consensus is that almost no one knows… what happens now?

The views expressed in this essay are personal and those of the author’s alone, and are not reflective of a company stance; readers and firms are encouraged to seek their own legal and tax advice prior to acting on the comments, ideas or opinions contained herein.